Research Paper: Consumption Tax Alternatives: Retail Sales

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[. . .] Similarly situated taxpayers should be taxed similarly.

Taxes should be based on the ability to pay.

Taxes should not be unduly distorted when income or wealth levels fluctuate over time.

No group of taxpayers should be favored to the detriment of another without good cause.

All taxpayers should pay what they owe on a timely basis (AICPA, 2009, p. 14).

With respect to promoting economic growth and efficiency, the tax system should not impede or reduce an economy's productive capacity, and it should encourage the taxing jurisdiction's economic goals. In general, the tax system should not favor one industry or investment type at the expense of others (AICPA, 2009, p. 15).

Other tax policy objectives should include transparency, minimizing noncompliance, cost-effective collection, favorable as much as possible impact on government revenues, certainty, and payment convenience (AICPA, 2009, pp. 15-16).

Income vs. Consumption Taxes

The current debate over tax reform involves three general structural approaches: making significant changes to the current system, replacing the entire current tax system, or making significant changes to the current system and adding a new tax regime. In addition to debating the appropriate structural approach to reform, one must likewise consider the conceptual debate over income taxation vs. consumption taxation.

In general, income taxes are considered more progressive, while consumption taxes are considered simpler and more conducive to economic growth. Under a consumption tax, income that is saved is not taxed, and the tax burden on income from saving and investment is eliminated. Given that the wealthy are more able to save than the poor, who must, by necessity, consume a larger portion of their incomes to meet living costs, consumption taxes generally place a greater overall burden on low income households than do income taxes. Similarly, a single-rate income tax rate structure would also shift the tax burden to lower income households as compared to a progressive tax structure.

Economists believe that "border tax adjustments" associated with consumption taxes do not have a significant impact on international trade, but they do however maintain a level international playing field. Some degree of complexity is unique to the income tax, so switching to a pure consumption tax would eliminate this complexity, particularly when taxing businesses and income from savings and investment. Under a consumption tax, most income generated by personal saving would effectively be exempt from tax, eliminating the complicated rules that give preferential tax treatment to pensions, IRAs, tax-exempt bonds, annuities, and life insurance. (AICPA, 2009, pp. 22-23).

Consumption taxes will introduce new administrative and compliance issues that do not exist under the income tax. However, complex transition rules would be likely to be part of any shift to a consumption tax system to avoid penalizing taxpayers caught between the old income tax and any new consumption tax (AICPA, 2009, pp. 24-25).

If the income tax system is replaced by a consumption tax, state income tax administration and compliance burdens will increase in states that rely on federal tax statutes and guidance to determine adjusted gross income or the tax base for state income purposes, resulting in the need for states to create their own income tax rules. Moreover, if the federal government implements a consumption tax, the change could lead to a one time impact on price levels, depending on decisions that businesses make to cover the tax or absorb the cost. Imposing a consumption tax could lead to double taxation that would be viewed as unfair to many individuals who are using prior savings, already taxed as income, to consume, thereby subjecting those savings to a second consumption tax (AICPA, 2009, p. 26).

Retail Sales Tax

Most Americans encounter retail sales taxes every day. Forty-five states and numerous local jurisdictions levy sales taxes. These taxes are highly visible to taxpayers because they are shown separately from the purchase price on each taxable sales receipt (AICPA, 2009, p. 45).

To promote economic efficiency, a retail sales tax should tax all consumption equally to avoid distorting consumer choices and keep tax rates low. Only final sales by businesses to consumers should be subject to tax. In practice, however, states' retail sales taxes do not meet the ideal of taxing all consumption once. States often exempt many final goods and services, while levying tax on many intermediate goods. This practice results in under-taxation of some sectors and over-taxation of others (AICPA, 2009, p. 45).

In general, a sales tax is regressive, and therefore it follows that state governments, to reduce regressivity, exempt many goods and services, especially those considered to be necessities like food, clothing, and housing. Since purchases of necessities generally represent a larger fraction of income for the poor than for the wealthy, such exemptions enable greater tax relief for low income households. Other goods are exempt because they are considered "merit" goods that deserve public support, such as education and health care. Such exemptions generally increase tax authorities' administrative burdens and taxpayers' compliance burdens (AICPA, 2009, p. 46).

Even if all exemptions for consumer products were eliminated, the problem would still remain of separating taxable sales to consumers from nontaxable sales to businesses. State governments generally use one of two imperfect methods to segregate sales: they grant exemption certificates to business taxpayers or impose sales tax on some types of products regardless of the purchaser's status. As a result, retail sales taxes typically overtax final sales of some products and under-tax sales of others (AICPA, 2009, p. 46).

Evasion by business purchasers represents a challenge under a retail sales tax. Businesses, particularly closely held ones, can improperly claim exemption on items used for personal consumption. The problem of distinguishing business items from personal use items is not exclusively a retail sales tax problem, and is a significant concern under most tax systems. However, under income tax, businesses must be able to defend all deductions claimed, and even valid business deductions can be disallowed if improperly documented. Under retail sales tax there is a critical difference, in that evasion by retail sales tax purchasers would require auditing multiple taxpayers as opposed to auditing only the purchaser under other tax systems. Therefore the problem of evasion by business purchasers is not easily dismissed. Moreover, evasion by retail sellers is perhaps the most cited difficulty with a federal retail sales tax (AICPA, 2009, pp. 48-49).

The following points summarize highlights of recent retail sales tax proposals, Fair Tax Act of 2009 (H.R. 25) and a companion bill (S. 1025):

Repeal the income tax, employment tax, and estate and gift tax.

Impose a national sales tax on the use or consumption in eth U.S. Of taxable property or services.

Set the stated sales tax rate at 23% on the gross in 2011, which yields an effective rate of 30%, with adjustments to the rate in subsequent years.

Allow exemptions from the tax for property or services purchased for business, export, or investment purposes and for state government functions.

Allow a monthly sales tax rebate for families meeting certain size and income requirements.

Direct the Secretary of the Treasury to allocate sales tax revenues among (1) the general revenue, (2) the old-age and survivors insurance trust fund, (3) the disability insurance trust fund, (4) the hospital insurance trust fund, (5) the federal supplementary medical insurance fund (AICPA, 2009, pp. 49-50).

Arguments in favor of replacing the federal income tax with a generic retail sales tax include:

Familiarity to U.S. citizens of retail sales tax.

A retail sales tax does not have individual filing requirements.

A retail sales tax can be structured to be border adjustable.

Like other consumption taxes, a retail sales tax removes a bias against savings inherent in the income tax.

Arguments against replacing the federal income tax with a generic retail sales tax include:

The retail sales tax is viewed as regressive, however the regressive effect could be mitigated by exempting necessities like food, or by providing assistance to lower income households.

A federal retail sales tax would increase the compliance burden placed on retailers and businesses.

Replacing the current federal income tax system with a retail sales tax involves significant transition issues, and would also impair the ability of states to administer their own income tax systems.

Combined state, local, and federal sales tax rates would be extremely high if a federal rate were imposed in the 20 to 30% range, which raises questions about the ability to enforce the tax effectively (AICPA, 2009, pp. 50-51).

Flat Tax

A flat tax refers to a single-rate consumption tax collected from both individuals and businesses. The flat tax example that the AICPA examines, S. 1040 proposed in 2007, has 2 components. Individuals would be taxed on the value added by labor through a wage tax; all other value-added tax (VAT) would be collected from business using a subtraction method VAT but modified to allow a deduction for wages (AICPA, 2009, p. 76).

Under the proposed S. 1040, individuals would pay a wage tax at a flat rate of 17%, after an initial tax rate of 19%… [END OF PREVIEW]

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APA Format

Consumption Tax Alternatives: Retail Sales.  (2011, August 18).  Retrieved June 26, 2019, from

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"Consumption Tax Alternatives: Retail Sales."  18 August 2011.  Web.  26 June 2019. <>.

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"Consumption Tax Alternatives: Retail Sales."  August 18, 2011.  Accessed June 26, 2019.